Unlike their corporate counterparts, freelancers are responsible for deducting independent contractor taxes from their incomes. To make things even more complicated, most independent contractors need to pay these taxes on a quarterly rather than annual basis. Four times a year, freelancers across the country sit down and try to figure out exactly what to pay — and how to pay it.
All of this probably seems confusing if you’re a first-time freelancer. How do you ensure that you have enough set aside in advance to pay? Thankfully, there are things you can do to prepare. These simple tricks take the worry out of quarterly taxes, which means you’ll always be prepared to pay off your taxes.
1. Open a Specific Account for Your Tax Liability
First and foremost, open up an account specifically for the money that goes towards your taxes. I recommend formally incorporating your business, so that you can create a business savings account. Unlike your primary checking account for freelancing — which you can use as an operating account to collect revenue, pay yourself and expenses — a business savings account has one sole purpose: It holds your tax liability leading up to quarterly and annual taxes. When you open the account, deposit an extra $200 so that when you withdrawal money for taxes you’ll never overdraw the account.
2. Calculate Your Estimated Tax Liability
If you’re new to freelancing, you don’t have to pay quarterly taxes during the first year. That said, it’s just as important that you save in advance to pay all taxes by April 17, 2018. Either way, set aside between 25 to 30 percent of your revenue every time that you receive a payment from a client. I’ve built this process into my weekly bookkeeping. Every time I process a payment, I transfer 30 percent of it into my special savings account. Some people set up automatic transfers, but I prefer doing it manually.
When it’s time to pay quarterly taxes, you can take two different approaches:
- Calculate your tax liability using Form 1040-ES
- Use last year’s tax liability as a benchmark. Divide that amount by four, and pay it over each quarter.
Although these two methods are both simple and effective, independent contractor taxes are complicated (even for people who are fluent in freelancer finances). Based on your comfort level (and the complexity of your business), you may benefit from speaking directly to an accountant or a bookkeeper to help you hit the mark.
3. Save the Extra Money Set Aside for Taxes
One of the biggest complaints I hear from freelancers is that they don’t pay enough in quarterly taxes. When April rolls around, freelancers sometimes owe more money in federal and state taxes than they realized — despite having done their due diligence throughout the process. If you don’t plan for it, it can be an awful surprise.
To make sure I’m not caught without the money to file an annual return, I leave any leftover money from quarterly taxes in my savings account until April 17 of the following year. I save more than enough, and I leave extra revenue in the account for the explicit purpose of helping me file the annual return. If I don’t need it, I get a nice bonus after paying off my tax liability.
Freelancing can be a challenge for many reasons, and taxes are definitely one of them. In this particular case, prudence is your best way forward. By saving more than enough in a separate account, you set yourself up for a bright future. Do you have any other tactics that take the pain out of independent contractor taxes?